Economic headwinds challenge Kraft

NORTHFIELD, Ill. – Last year at this time, Kraft Foods Group, Inc. issued its first quarterly results as an independent company following its split from Mondel?z International, Inc. Tony Vernon, CEO, expressed his belief at that time that Kraft had laid a solid foundation for the future of its $19 billion business in the face of an economic environment that has not improved.

While the economic environment remains challenging, Vernon this week said the unusual nature of last year’s third quarter obscured the company’s “steady progress” in remaking its food and beverage portfolio. Last year the company shipped safety stock to retailers ahead of a systems changeover as part of the spin-off from Mondel?z International.

Cost-cutting moves helped Kraft generate net income in the third quarter ended Sept. 28 of $500 million, equal to 84 cents per share on the common stock, up 7 percent from $466 million, or 79 cents per share, in the third quarter of 2012. Net revenues were $4,394 million, down 4 percent from $4,588 million.

Operating income in the third quarter was $870 million, up 15 percent from $757 million a year ago. Results for the 2013 quarter included $175 million in market-based impacts to post-employment benefit plans driven by higher discount rates and higher asset returns.

One of the areas of strength for Kraft during the third quarter was the company’s Cheese business, where operating income increased nearly 8 percent to $171 million from $159 million in the same period a year ago. Revenues increased 0.9 percent to $922 million from $914 million, as higher prices and steady growth in Kraft natural cheeses and Velveeta slices more than offset the negative volume impact from comparisons with spin-off related shipments in the prior-year period.

In Refrigerated Meals, Lunchables and Oscar Mayer bacon and hot dogs performed well, even as year-over-year revenues for the segment fell 0.7 percent to $878 million. Operating income was $78 million, down 32 percent. The decline was due to a negative impact from pricing net of commodity costs versus the prior year.

In an Oct. 30 conference call with analysts, Vernon elaborated on what he called “a tough cold cuts year.”

“What is going on in cold cuts is a very interesting phenomenon,” he said. “And that is, a big competitor comes in — and I would name them Tyson, right? Who grabs the low-end of the price point, a formidable one. We probably should have acted sooner. I said that.

“And importantly, great marketing by the deli competitors. And you know their names. I don’t want to give them too much credit. But we have seen 4 share points move from a processed lunch meat to the deli counter.”

With new leadership on board, Vernon said Kraft has the opportunity to “bring some fresh eyes, a different way of looking at it.”

“I think you’re going to see us doing some of the things out of the old play book, and some of the things to grab back that cold cuts share,” he explained. “It is a critically important business to us and to the retailer. It is a big part of Kraft, and it is something we have built a lot of growth on over the years, and are looking at a tough 15 months or so. But I do believe sequentially you are seeing improvement, and you’re going to see innovation and strategic pricing moves to improve it even more.”

A sharp decline in operating income also occurred in the company’s Beverages unit. At $50 million, operating income in the unit was down 34 percent from the same period a year ago. Revenues fell 8 percent to $625 million, though Kraft did note improved product mix from on-demand coffee, liquid water enhancer innovations and Gevalia premium coffee.

Operating income in Meals and Desserts was $146 million, down 15 percent from $171 million on lower volumes. Revenues declined 6 percent due to negative volume impact from comparisons with spin-off related shipments in the prior-year period. Excluding this factor, Kraft said ongoing growth of Velveeta dinners was largely offset by softness in Jell-O desserts.

In Enhancers and Snack Nuts, operating income was flat at $129 million. Revenues fell 10 percent due to “volume weakness in salad dressings and mayonnaise as well as lower prices driven by lower nut costs versus the prior year,” Kraft said. The factors more than offset solid volume growth and improved product mix from Planters snack nuts.

While the impact from last year’s spin-related trade inventory was key to the company’s year-over-year performance during the third quarter, Tim McLevish, CFO, said Kraft is “on track” to deliver underlying earnings and cash flow targets previously announced.

He said Kraft expects organic net revenue growth in line with growth of the North American food and beverage market, full-year earnings per share of about $3.58 (versus $3.40 previously) and free cash flow of approximately $1.2 billion.